Finance can sometimes be more taboo than sex.
Some Singaporeans are more willing to discuss details about their sex lives than their current financial status. It is also challenging to perform a benchmarking exercise with your peers, thanks to the availability of cheap credit – that friend of yours who drives a European car probably took a hefty loan to own it.
2 ways to determine how much your net worth should be
But this does not stop people from wanting to compare with each other.
This article discusses two ways to determine whether your net worth is up to par with your peers.
1) The Simple Approach: Average Accumulator of Wealth formula
In Thomas Stanley’s The Millionaire Next Door, he suggests a simple formula to determine what the Average Accumulator of Wealth (AAW) should have. It would help if you had one-tenth of your age multiplied by your annual income from all income sources.
This formula is as follows :
Average Accumulator of Wealth (AAW) = 0.1 x Age x Annual Income
Your annual income should be after-tax, and it should include all sources of income, so this should also consist of the employer’s CPF contribution, dividends and royalties.
For example, if Tan Ah Kow, age 35, earns $100,000 annually and pay 10% taxes, his employer contributes 17% of his income to CPF or $17,000 a year. Tan Ah Kow’s annual income is 90% of $100,000 plus $17,000 or $107,000.
According to this approach, Tan Ah Kow should have a net worth of about 0.1 x 35 x $107,000 or $374,500.
| Amount | |
| Annual Income before tax | $100,000 |
| Employer CPF Contribution (17%) | $17,000 |
| Taxes (10% on annual income) | -$10,000 |
| Tan Ah Kow’s AAW (0.1 x 35 x $107,000) | $374,500 |
Thomas Stanley estimates that those who qualify as rich should have twice as much as the AAW. Those who meet this benchmark are known as Prodigious Accumulators of Wealth or PAWs. To be eligible as a PAW, Ah Kow would need $374,500 x 2 or $749,000.
Downside of using AAW
This approach towards estimating the “appropriate” net worth came under heavy criticism because it is almost impossible for a fresh graduate at age 25 to accumulate 2.5 x Annual Income when they have only started earning their income. Adopting impossible standards is not very encouraging to younger professionals.
The numbers are also too clean, and we’re not sure whether it gels with our reality in Singapore.
2) The Data-Driven Approach – Using Singapore Statistics
Having a formula is fine and good, but does it reflect the reality in Singapore?
My biggest grouse is the coefficient of 0.1 that we use to calculate the proper AAW net-worth.
Why should it be one-tenth of our age?
Why not half or double that amount?
The number (A) seems arbitrary to me. Is it possible to derive a better estimate?
Here is some data I picked up from the web:
- The median age in Singapore is 42.2 years old.
- The median income per month is $4,534 per month. We will estimate monthly taxes of $300. After adjusting for the employer’s CPF, we will have ($4,534 x 1.17 – $300) or very close to $5,000 per month or $60,000 a year.
- According to smartwealth.sg, the median wealth in Singapore is shockingly low at $117,068.
We can plug these three data points into an equation to calculate the Median Singaporean Accumulator of Wealth or MSAW.
- MSAW = A x Age x Annual Income
- $117,068 = A x 42.2 x 60000
- A = $117,068 / (42.2 x $60,000)
- A = 0.046
We will only need to accumulate much less by using a data-driven approach to calculate how much we will need to have as benchmarked against the median Singaporean.
The formula should instead be :
MSAW = 0.046 x Age x Annual Income
If we use these numbers grounded in reality, then our fictional character Tan Ah Kow can take a break.
At age 35, with an annual income of $107,000, Tan Ah Kow should have a net worth of about 0.046 x 35 x $107,000 or $172,270. He can take his home equity and CPF into consideration. He can consider himself rich if he has 2 x $172,270 or $344,450.
| Amount | |
| Annual Income before tax | $100,000 |
| Employer CPF Contribution (17%) | $17,000 |
| Taxes (10% on annual income) | -$10,000 |
| Tan Ah Kow’s MSAW (0.046 x 35 x $107,000) | $172,270 |
Anxiety comes with comparing yourself to others
In this exercise, we provided two approaches to estimating what the ideal net worth is should be for you, the reader. As you can see, the formula can vary itself depending on which data-point you use. If you can shift from median data to mean data, coefficient A can even become higher than 0.1.
The best attitude to adopt towards models is that they are always wrong, but they can still be helpful.
For the model to benefit you, you should use it to motivate yourself and not cause too much consternation should you fall too low against the target.
Unlike the PSLE, there is no one around to hand you a grade or a t-score when you receive your final paycheck in this lifetime.